PAF 9130 – Economic Analysis of Public Policy
PAF 9130 – Economic Analysis of Public Policy
Fall 2016
Problem Set #3
Ground Rules
You are encouraged to work with other class members on this problem set, but
each person must write up their answers separately and in their own words.
Answer questions in words and graphs.
Please type answers and use 12-point front (graphs may be drawn by hand, but
please make them large.)
The due date for this assignment is Wednesday, November 16th at the beginning
of class. Late assignments will not be accepted.
1. Tax
A country which does not tax cigarettes is considering the introduction of a $0.40 per
pack tax. The economic advisors to the country estimate the supply and demand curves
for cigarettes as:
QD = 140,000 – 25,000P QS = 20,000 + 75,000P,
where Q = daily sales in packs of cigarettes, and P = price per pack. The country has
hired you to provide the following information regarding the cigarette market and the
proposed tax. Explain in words and graphically.
a. What are the equilibrium values in the current environment with no tax?
b. What price and quantity would prevail after the imposition of the tax? What portion of
the tax would be borne by buyers and sellers respectively?
c. Calculate the deadweight loss from the tax. Could the tax be justified despite the
deadweight loss? What tax revenue will be generated?
2. Public Policy
One of the provisions of the 2010 Patient Protection and Affordable Care Act, popularly
known as Obamacare, was a mandate that required large employers to pay for employee
health insurance or face a penalty. Given what you have learned about taxes, who in
reality is paying the taxes? Start your analysis with justifiable assumptions on elasticities
of Supply and Demand. Discuss whether the law is a good or bad idea. Explain in words
and graphically.
In addition, Obamacare requires people to buy health insurance regardless of their health
status under the penalty of fines for failing to do so. What is the justification for requiring
this based on economics? What concerns based on economic principles have been raised
against this requirement?
3. Optimal Choice
Assume Carolyn is given a bundle on her budget constraint where her MRSFC = 2. Also
assume the price of a unit of food equals $3 and the price of a unit of clothes equals $6.
Should Carolyn buy more food or more clothes to maximize her utility? Why? Explain
in detail.
4. Effect of Government Programs
Assume that the budget constraint shown is for $600 of income with a price of food equal
to $2 and a price of clothes equal to $4. With an indifference curve and budget constraint
as shown, will a TANF grant of $200 have the same effect on food consumption as $200
in food stamps? Why? Explain in words and graphically. Note that you must use the
scale provided in the picture.
Clothes
Budget Constraint
Indifference Curve Food
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